By Sarah N. Lynch and Emily Stephenson
WASHINGTON, Feb 19 (Reuters) - Exchanges and other trading
platforms would have to perform tests to prevent software errors
from unleashing havoc on the market under proposed rules being
crafted by regulators, U.S. Securities and Exchange Commission
Chairman Elisse Walter said.
Walter offered details for the first time on the rules,
which are being developed in response to a string of
high-profile technology errors last year, in a speech Tuesday at
American University's Washington College of Law.
Those debacles include Nasdaq's botched handling of
the Facebook initial public offering and Knight Capital's
$440 million losses due to a software error.
Walter's predecessor, Mary Schapiro, announced last year she
was putting the rule-writing process on the fast track, shortly
after Knight Capital nearly went bankrupt.
Walter said the rules will require exchanges, alternative
trading systems and clearing agencies to provide notifications
about systems disruptions and meet certain technological
standards, as well as perform business continuity testing.
Entities could be punished if they fail to comply with any
such tighter compliance rules.
"We saw how automated markets and computer-driven trading
can go awry when technical issues in Knight Capital's trading
and routing software caused it to erroneously establish
positions in nearly 150 stocks, ultimately costing the company
$440 million," Walter said.
The regulator will try to eliminate the causes of
uncontrolled electronic trading, not just the problems, by
concentrating on compliance and integrity, she said.
The SEC's proposed rules would replace a long-time voluntary
standard known as "automation review policies" or ARP.
The SEC first developed ARP following the 1987 market crash.
ARP sets forth guidance for exchanges, some alternative trading
systems and clearing agencies to help ensure their systems are
stable, secure and have the capacity to deal with glitches that
can send markets into a tailspin.
In addition to converting the voluntary guidance into
enforcement rules, the SEC is also considering whether to expand
the program to apply to other entities, such as broker-dealers,
advisers and dark pools. [ID nL1E8KE0YV]
Walter conceded that many market participants are already
following ARP guidelines today, but said a voluntary policy does
not go far enough.
"In my mind, a voluntary standard is no substitute for a
mandate or a requirement that you must follow, and that you
violate the law if you fail to follow it," she said.
Walter did not provide a timetable for the proposal's
unveiling, saying some details remained under discussion. She
later told reporters it is "top of mind and top of the agenda"
and would be released "sooner rather than later."
It is unclear, however, if Mary Jo White, President Barack
Obama's nominee to become the next SEC chairman, will also
prioritize the rulemaking. Walter is expected to remain as
chairman until the Senate confirms White, a former prosecutor
and white-collar defense attorney.
RISE OF THE MACHINES
The SEC has been exploring numerous possible market
structure changes in response to the rise of automated trading.
It implemented a handful of reforms after the May 6, 2010
"flash crash," when the Dow Jones industrial average plunged
about 700 points before rebounding.
The SEC is also exploring the policies surrounding
high-frequency trading and its impact on investors.
The commission is capturing data for all orders,
cancellations and trade executions through a Market Information
Data Analytics System, or MIDAS, in an effort to better
understand high-frequency trading, she said.
After the staff gets a chance to analyze it, Walter said the
SEC will release some of its studies to the public.
Among the things she said staff may study include the impact
of quote cancellations, changing the tick size, the depth of
book for liquid and illiquid stocks, and intraday volatility.
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